The short answer: every dollar of depreciation you deducted (or were entitled to deduct) while owning a rental property is "recaptured" when you sell, taxed federally at up to 25%: a higher rate than long-term capital gains, and recognized first. On a long-held property, recapture is routinely the largest single line of the tax bill. A properly executed 1031 exchange defers all of it.
Ask an owner what they expect to pay in tax when they sell, and they will usually quote the capital gains rate on their appreciation. Ask their CPA, and you'll get a longer answer. Across the exchanges we advise, depreciation recapture is the number that most often stuns people at the closing table, precisely because it has nothing to do with how much the property went up in value. It is the government reclaiming the deductions that sheltered your rental income for years. This guide explains how recapture works, shows the arithmetic on a realistic sale, and walks through how exchange structures, including Delaware Statutory Trusts, defer the entire amount.
What depreciation recapture actually is
Residential rental buildings are depreciated over 27.5 years (39 for commercial): each year, roughly 1/27.5 of the building's value is deducted against your rental income. Those deductions are real money: they shelter income at your ordinary tax rate for decades. But they also reduce your cost basis, and when you sell, the IRS treats the portion of your gain attributable to depreciation differently from ordinary appreciation. That slice, called unrecaptured Section 1250 gain, is taxed at a maximum federal rate of 25%, ahead of the 15–20% long-term capital gains rate that applies to the rest.
Two features make recapture uniquely dangerous to underestimate:
- It is recognized first. When gain is taxed, the recapture layer comes off the top before capital gains rates apply. Partial sales and taxable boot hit recapture before anything else, which is why even a small shortfall in an exchange can be taxed at the higher rate.
- It applies whether or not you took the deduction. The tax code recaptures depreciation that was "allowed or allowable." An owner who never claimed depreciation on their returns still owes recapture as if they had. There is no credit for modesty, only a missed deduction and the same bill at the end.
A worked example: the tax bill nobody quoted
Say you bought a rental property fifteen years ago for $800,000, of which $600,000 was the building (land does not depreciate). You have deducted roughly $21,800 a year, $327,000 in total, and today you sell for $1,300,000.
| Line | Amount |
|---|---|
| Depreciation taken over 15 years | $327,000 |
| Recapture tax at 25% | ~$81,800 |
| Federal capital gains on remaining $500,000 gain (20%) | $100,000 |
| Net investment income tax (3.8%) | ~$31,400 |
| State tax (California example) | ~$110,000 |
| Total tax without an exchange | ~$323,000 |
A quarter of the total bill has nothing to do with appreciation: it is the recapture of deductions already spent. And note the state line: most states tax recapture as ordinary income with no preferential rate at all. Our Capital Gains Calculator runs this arithmetic for your own numbers, including recapture, in about a minute.
Why long-hold owners get hit hardest
Recapture grows mechanically with time. An owner ten years in has taken ten years of deductions; an owner thirty years in, through one or more prior exchanges, may have a cost basis near zero, which means nearly the entire sale price is gain and a large share of it is recapture-rate gain. Owners who completed cost segregation studies or claimed bonus depreciation accelerated those deductions and, with them, the eventual recapture (some of which can be taxed at ordinary rates rather than the 25% cap). None of this is a reason to skip depreciation: deductions today are worth more than tax deferred tomorrow. It is a reason to plan the exit as carefully as the hold.
How a 1031 exchange defers recapture in full
A like-kind exchange defers recognition of the entire gain: the capital gains layer and the recapture layer together. Your old basis carries into the replacement property and depreciation simply continues on its schedule. There is no separate recapture toll for exchanging; the three rules of a fully deferred exchange (equal or greater value, all equity reinvested, debt replaced) are the same ones that protect the capital gains layer. The reverse is also true: any taxable boot you create is taxed as recapture first, at the higher rate, which raises the stakes of the closing-table arithmetic we covered in our guide to boot.
For owners who are done with active management, a DST interest qualifies as like-kind replacement property and defers recapture identically, while ending the landlord workload. DSTs are offered to accredited investors through private placement and carry their own risks, fees, illiquidity, and hold periods; they fit some situations well and others not at all.
The long game: deferral that can become elimination
Deferred recapture does not have to come due at all. Under current law, when exchanged property passes to your heirs, they generally receive a step-up in cost basis to fair market value, and the accumulated recapture liability, along with the deferred capital gains, is eliminated rather than inherited. That is the engine behind the "swap 'til you drop" strategy many of our long-hold clients follow. Your CPA and estate attorney determine how this applies to your situation; our role is keeping the deferral intact along the way.
Frequently asked questions about depreciation recapture
What rate is depreciation recapture taxed at?
Unrecaptured Section 1250 gain on real property is taxed at your ordinary income rate up to a maximum of 25% federally, plus the 3.8% net investment income tax where it applies, plus state tax: most states tax it as ordinary income.
Does a 1031 exchange defer depreciation recapture?
Yes, in full. A properly structured exchange defers both the capital gains and the recapture layers of your gain. Basis and the depreciation schedule carry over into the replacement property.
I never claimed depreciation. Do I still owe recapture?
Generally yes. The rule is "allowed or allowable": recapture is computed on the depreciation you were entitled to take, whether or not you took it. Your CPA may be able to catch up missed deductions before a sale.
Does recapture apply if I sell at a loss?
If you sell for less than your adjusted basis, there is no gain and generally no recapture. But because depreciation lowers your basis every year, properties that feel like break-even sales often still produce taxable gain.
Can recapture be eliminated rather than deferred?
Under current law, heirs who inherit exchanged property receive a stepped-up basis, which generally eliminates the deferred recapture along with deferred capital gains. Consult your estate attorney and CPA on how this applies to you.